Changes ahead! Is your Income Protection Policy road worthy?

8 points to consider when choosing the right Income Protection Policy. 

Your ability to earn income is your most important asset so having a plan in place when you are forced off the track and require a tune up from your mechanic is vital. An Income Protection (IP) Policy can assist to smooth out the bumps in the road ahead (including the earmarked APRA changes come 31 March 2020.) Not all IP cover is created equally and there can be many moving parts required to act in sync for peak performance.

Comprehensiveness

  • Does your policy have a 3 tier definition of totally disabled? Is there a waiting period requirement to be totally disabled for a certainty period of time in order to be eligible for a payment?
  • A comprehensive policy will have a 3 tier definition of total disablement – time, income or duties based. They also shouldn’t have a waiting period requirement for the life insured to be totally disabled for a specific time during the waiting period.

Waiting period (WP)

  • What is your waiting period? Typically any period of 30 days or fewer will add significant cost to your policy premium so perhaps consider a longer waiting period if your personal reserves will allow you so.
  • On the flip side, if you have substantial financial obligations (i.e. loan repayments) that are on short term recurring payment cycles, it may be worth matching your waiting period to their frequency.

Benefit Period (BP)

  • Do you know your benefit period? The benefit period can range from a couple to several years, 2 or 5 years or a specific age date, to age 65 or even 75.
  • Typically if you are off work due to illness or injury for a period of 60 consecutive days or longer, the likelihood of you returning to the workforce is less than a 50/50 chance. That means you need to consider, if you have a 2 or 5 year benefit period, what is your plan post this time frame? If you don’t have other means of support you may be left financially vulnerable.

Benefit Amount

  • Are you maximising your benefit amount? Or perhaps you only need to secure a portion of your income to meet your lifestyle and financial obligations.
  • Generally you can insure up to 75% of your personal exertion income (salary and wages) including super payments (SGC and/or salary sacrifice).

Cover Type (Agreed vs Indemnity)

  • Is your policy an agreed or indemnity contract?
  • Agreed cover provides peace of mind around certainty of benefit payment at the time of the claim. This is done by providing supporting materials such as tax returns, employment contracts, etc. at application stage to back up the cover amount taken out.
  • An indemnity policy places the emphasis on the life insured to provide proof (financial evidence) at the time of the claim to support the benefit payment. The life company will pay you the lesser of the benefit amount or an amount you are able to support. These types of policies are cheaper due to their lack of certainty.
  • As of 31 March 2020, you will no longer be able to commence Agreed type cover. So, if you would like certainty of benefit amount at claim time, it would be worth taking out an Agreed policy now.
  • Substantial additional changes to the IP market are also coming! For the full list of expect changes visit the APRA website.

Premium Structure

  • Is your policy stepped or level?
  • Stepped premiums are more suited to a short term requirement. They start out comparatively cheaper but increase year on year (approx. 10-15%) as the life insured ages, reflecting an increased risk to the life company.
  • Level cover is more appropriate for longer term needs. They are not fixed but should remain consistent (outside of a repricing of the book by the life company or indexation of the benefit amount) over the life of the policy. They are comparatively more expensive in the initial years but will be cheaper over the long term.
  • Usually, income protection is for a long term purpose (securing income over your working life) therefore a level premium structure will tend to be more appropriate (cost wise).

Ownership Structure

  • How is your policy held – personally or through super?
  • Holding an IP policy through superannuation can lead to issues such as access (need to not only meet the terms and conditions of the policy but a condition of release from superannuation. Where the two requirements don’t match, the benefits can be quarantined in the super environment) and certain of benefits (unable to attain agreed cover through super).
  • If the policy is held personally, payments will be made directly to the policy holder. Agreed cover is able to be taken out and a tax deduction for the premiums paid can be claimed, potentially making the after tax cost of the policy significantly cheaper.

Claims Indexing

  • Is your benefit amount indexed if you were to go on claim? Claims indexing allows you to keep pace with inflation over time. A restrictive policy will lock your benefit amount at commencement of the claims period thus reducing your purchasing power each year you remain on claim.
  • Normally this is add on feature (at an additional cost to the policy holder) that you need to apply for (i.e. not built into the policy).

DISCLAIMER:  GENERAL ADVICE ONLY

The information provided in this blog is general in nature. It has been prepared without taking into account any person’s individual objectives, financial situation or needs.

Before acting on any information in this blog, you should consider its appropriateness to you, having regard to your objectives, financial situation and needs or seek professional advice from a financial advisor.

Accru are not recommending any investment or product, the investments mentioned are examples only. Please seek professional advice or do you own research for an appropriate investment.  

About the Author
James Grindrod - Financial Advisor
James Grindrod , Melbourne
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